Fight brewing over U.S. offshore profit taxation

Sep 14, 2011, 4:05 a.m.

By Kevin Drawbaugh

WASHINGTON (Reuters) - Large U.S. corporations are pressuring Congress and the White House to exempt overseas corporate profits from taxes, a policy shift that critics say would hurt the economy and increase the federal deficit.

A fight is shaping up between supporters of territorial taxation, as this policy proposal is known, and opponents who favor a different reform -- repealing a tax law that allows corporations to defer paying taxes on their overseas income.

The two sides are facing off over an old and worsening problem -- how to fix the system for taxing companies' foreign income. Both sides agree the system is not working and a new approach is needed, but their solutions are direct opposites.

"A tax system that raises little revenue, but imposes high compliance and administrative burdens on taxpayers and the IRS is the very definition of a bad tax system. Unfortunately, that is the system we have," said Philip West, a former U.S. Treasury Department tax official, at a Senate hearing.

Case in point: business software and hardware giant Oracle Corp. Based in California, Oracle generates 60 percent of its nearly $36 billion in annual sales overseas.

Much of its overseas profit never comes home to the United States, however. Oracle has at least $20 billion in profits parked abroad avoiding taxation, and that is perfectly legal under the overseas income deferral law.

Oracle is a strong supporter of territorial taxation, along with many other Silicon Valley high technology companies, drug makers and other businesses with large foreign operations.

Under territorial taxation, in its strictest form, overseas profits of U.S. companies would be taxed only by the country where they are earned, no longer by the United States.

That would allow companies such as Oracle to bring home their active foreign business income tax-free or nearly so.

This would be a big change because, under present law, foreign profits are supposed to be taxed when they come home at the same 35-percent rate applicable to U.S. domestic profits.

The trouble is that many large multinationals -- like Oracle and others -- do not pay the full tax, or often any U.S. tax at all, on their foreign income.

That is because of the overseas income deferral law, which lets them put off indefinitely the payment of tax on active foreign earnings as long as the earnings remain abroad.

The solution to this problem is not to exempt those earnings permanently from U.S. taxation, say opponents of territorial taxation. Instead, they say, the solution is to repeal the overseas income deferral law.

That would make overseas profits immediately taxable, like domestic profits. And, proponents say, it would lift government revenues, perhaps making room for a corporate tax rate cut.

POSSIBLE SHIFT

The Obama administration is considering a limited version of territorial taxation, although details of its plan are still unclear, The Wall Street Journal reported on Saturday.

Multinational corporations have an estimated $1.5 trillion in profits parked overseas right now, avoiding taxes. They want to be able to bring those profits home tax-free, or with only a small tax hit, and they would like that arrangement to be permanent, as territorial taxation would accomplish.